University of California, Berkeley - Haas School of Business
Albert J. Menkveld
VU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA); Duisenberg School of Finance
September 5, 2012
WFA 2010 paper
We study price pressures - deviations from fundamental value due to risk-averse intermediaries supplying liquidity to asynchronously arriving investors. Empirically, New York Stock Exchange intermediary data reveal economically large price pressures, 0.49% on average with a half life of 0.92 days. Theoretically, a simple dynamic inventory model captures an intermediary’s use of price pressure to mean-revert inventory. She trades off revenue loss due to price pressure against price risk associated with staying in a nonzero inventory state. A closed-form solution identifies the intermediary’s risk aversion and the investors’ private value distribution from the observed time series patterns. These parameters imply a relative social cost due to price pressure - a deviation from constrained Pareto efficiency - of approximately 10% of the cost of immediacy.
Number of Pages in PDF File: 38
Keywords: liquidity, inventory risk, intermediary, volatility
JEL Classification: G12, G14, D53, D61Accepted Paper Series
Date posted: May 31, 2009 ; Last revised: September 6, 2012
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